Lesson_65_Fiscal Policy with Flexible Exchange Rates

Lesson_65_Fiscal Policy with Flexible Exchange Rates -...

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1 Lesson 65 1 Fiscal Policy with Flexible Exchange Rates Suppose the economy is in an equilibrium with excessive unemployment Can fiscal policy be used effectively to stimulate output? This lesson incorporates effect of fiscal policy on exchange rate to answer this question Lesson 65 2 Start with IS-LM Y i 1 IS 1 LM 1 Y 1 i F Y Lesson 65 3 Expansionary fiscal policy shifts IS to right Y i 1 IS 1 LM 1 Y 1 i F Y
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2 Lesson 65 4 If interest rate did not change, would want to shift IS to point where i 1 intersects with Y F Y i 1 IS 1 LM 1 Y 1 i F Y Lesson 65 5 But higher interest rate “crowds out” interest-sensitive spending, blunting effectiveness of fiscal policy Y i 1 IS 1 LM 1 Y 1 i F Y Lesson 65 6 Have to be more aggressive, shifting IS further rightward Y i 1 IS 1 LM 1 Y 1 i F Y 2 IS
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Lesson 65 7 But that’s not the end of the story Y i 1 IS 1 LM 1 Y 1 i F Y 2 IS Lesson 65 8 Higher interest rate makes U.S. assets attractive financial investment Y i 1 IS 1 LM 1 Y 1 i F Y 2 IS Lesson 65
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Lesson_65_Fiscal Policy with Flexible Exchange Rates -...

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